TODAY’S STUDY: CUTTING THE EDGE WITH COMMUNITY WIND

One of the most AND least obvious solutions for the dilemma that is U.S. energy is distributed New Energy, like big box rooftop solar and local wind turbines, that generate significant amounts of energy near to the communities that need it.

The U.S. energy dilemma comes from the increasingly urgent but almost contradictory needs for more generation and cheap generation. The obvious solution is building distributed New Energy because it goes up quickly, requires little costly new transmission infrastructure and generates domestic, emissions-free, jobs-creating power.

But distributed New Energy - although paying itself off and handsomely earning back its costs in the long term - requires dauntingly high upfront financing.

The paper highlighted below offers a way out of the conundrum by describing how a series of distributed "community wind" projects were creatively financed, using the blessings of the Recovery Act, and put to work quickly in service to localities across the country despite hard economic times.

Community Wind: Once Again Pushing the Envelope of Project Finance
Mark Bolinger, January 2011 (Lawrence Berkeley National Laboratory Environmental Energies Technology Division)

Executive Summary

The “community wind” sector in the United States – defined in this report as consisting of relatively small utility-scale wind power projects that sell power on the wholesale market and that are developed and owned primarily by local investors – has historically served as a “test bed” or “proving grounds” not only for up-and-coming wind turbine manufacturers trying to break into the broader U.S. wind market, but also for wind project financing structures. For example, a variation of one of the most common financing arrangements in the U.S. wind market today – the special allocation partnership flip structure (as described in Section 2.1 and Figure 1 of the full report) – was first developed by community wind projects in Minnesota more than a decade ago before being adopted by the broader wind market.

More recently, a handful of community wind projects built over the past year have been financed via new and creative structures that push the envelope of wind project finance in the U.S. – in many cases, moving beyond the now-standard partnership flip structures involving strategic tax equity investors. These include:

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 a 4.5 MW project in Maine that combines low-cost government debt with local tax equity,

 a 25.3 MW project in Minnesota using a sale/leaseback structure,

 a 10.5 MW project in South Dakota financed by an intrastate offering of both debt and equity,

 a 6 MW project in Washington state that taps into New Markets Tax Credits using an “inverted” or “pass-through” lease structure, and

 a 9 MW project in Oregon that combines a variety of state and federal incentives and loans with unconventional equity from high-net-worth individuals.

Details of the financing structures used for each project are described in Section 4 of the full report. In most cases, these are first-of-their-kind structures that could serve as useful examples for other projects – both community and commercial wind alike.

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Much as the partnership flip structure was first devised in response to the specific nature of federal policy support for wind power projects – specifically, the inability of most individuals to make efficient use of the production tax credit (“PTC”) and accelerated depreciation – so too has this new wave of financial innovation in the community wind sector been driven by policy changes, most of them recent. For example, as described in Section 3 of the full report, the American Recovery and Reinvestment Act of 2009 enables, for a limited time, wind power (and other types of) projects to elect either the 30% investment tax credit (“ITC”) or a 30% cash grant (the “Section 1603 grant”) in lieu of the PTC. This flexibility, in turn, enables wind power projects to pursue lease financing for the first time – neither the ITC nor the cash grant is subject to the PTC’s requirement that the project owner also operate the project in order to be eligible for the incentive. The ITC and Section 1603 grant also reduce performance risk relative to the PTC, and (unlike the PTC) neither the ITC nor the grant is penalized for the use of subsidized energy financing. Finally, by providing a cash rather than tax incentive, the cash grant alone reduces (but does not eliminate) the need for tax appetite among project owners. All of these policy driven changes can be particularly useful to community wind projects.

Other policy-related enablers of some of the financial innovation profiled in this report include New Markets Tax Credits – which are not new but have only recently been tapped to help finance solar projects and, for the first time, in 2010 have been part of a community wind project financing – and Section 6108 of the 2008 Farm Bill, which expands the USDA’s authority to loan to renewable generation projects, even if those projects are not serving traditional rural markets.

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The collective experiences of the five community wind projects profiled in Section 4 of the full report can be distilled into the following common observations or lessons learned (described further in Section 5 of the full report) regarding the development and financing process:

 The Recovery Act, and in particular the Section 1603 cash grant, has been critically important to most of these projects. Although the deadline to qualify for the grant has been extended through 2011, wind projects must still be online by the end of 2012 to receive the grant or ITC in lieu of the PTC (which is also currently slated to expire at the end of 2012). Efforts to extend one or more of these incentives will no doubt be underway throughout 2011 and 2012, but at present the window of opportunity to take advantage of the grant in particular is relatively short.

 Don’t overlook the need for seed capital. Many analysts and financiers tend to focus on construction and permanent financing, but most of the projects reviewed in this report had spent upwards of half a million dollars in seed capital before even getting to the construction financing stage. Raising this amount of seed capital – much of which is spent on relatively fixed development costs – can be a significant hurdle for community wind projects, and in particular smaller community wind projects.

 Piggybacking on nearby projects can help ease the burden. One project reviewed in this report was under construction within a year of being conceived, thanks in large part to the benefits of piggybacking on (i.e., leveraging) another project’s development work.

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 Partnering with experienced professionals can create opportunities. Although the projects profiled in this report are modest in size, they are nevertheless complex undertakings involving novel financing structures, which in many cases represent industry firsts. Most of these projects have benefited greatly from the assistance of experienced financial consultants or advisors.

 Consider the RUS as a source of debt. The USDA’s Rural Utility Service has traditionally financed infrastructure associated with rural electric cooperatives, but does have the authority to lend to standalone wind projects on a non-recourse basis, and has done so at least twice in the past two years. Moreover, a provision in the 2008 Farm Bill makes it easier for the RUS to loan to wind projects, even if they’re not serving traditional rural markets. RUS debt is typically guaranteed by the USDA, and therefore has a very attractive interest rate.

 Don’t overlook New Markets Tax Credits (“NMTCs”). Given their typically small size, community wind projects should generally strive for greater simplicity rather than increased complexity in financing structures. The realities of the market, however, often require that complex financing structures be employed in order to maximize available incentives. For this reason, NMTCs are worth keeping in mind should an appropriate opportunity present itself. Although NMTCs can be complex to structure, they do provide quite a bit of value (on a present value basis, effectively the equivalent of a second ITC), which in some cases could justify the high transaction costs of pulling together an NMTC deal.

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 Be prepared for a long haul. Three of the five projects profiled in this report have endured development cycles of five years or longer, which requires patience, tenacity, and adequate development capital.

 The shift from construction to operations can bring new challenges. Although this report focuses primarily on project financing, the challenges do not necessarily end once a project has been financed and built. Several of the projects reviewed in this report have recently shifted from the construction phase to the operational phase, and are now facing operational challenges ranging from integration issues to complying with noise regulations.

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Common Observations and Lessons Learned

This section concludes the report by attempting to distill the collective experiences of the five community wind projects profiled in Section 4 into a number of common observations or lessons learned regarding the development and financing process – in particular those observations or lessons that might be useful to other community wind projects and stakeholders.

5.1 The Recovery Act Has Been Critically Important to Most of These Projects

The Recovery Act, and in particular the Section 1603 grant, has been critically important to most of these projects. By reducing the need for tax equity, the Section 1603 grant enabled South Dakota Wind Partners to find sufficient equity capital among individual investors (presumably some of whom would not have been able to absorb passive depreciation losses in addition to a PTC or an ITC), and simplified the financing of the PáTu project. The ability to pursue lease financing under the ITC or grant was obviously critical to the success of the Ridgewind and Coastal Energy projects. Finally, the Recovery Act’s elimination of the ITC’s (and grant’s) double-dipping penalties for subsidized energy financing has eliminated the risk that PáTu’s term loan from Oregon’s Energy Loan Program might be considered subsidized financing.

Although the deadline to qualify for the grant has been extended through 2011, wind projects must still be online by the end of 2012 to receive the grant or ITC in lieu of the PTC (which is also currently slated to expire at the end of 2012). Efforts to extend one or more of these incentives will no doubt be underway throughout 2011 and 2012, but at present the window of opportunity to take advantage of the grant in particular is relatively short.

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5.2 Don’t Overlook The Need for Seed Capital

The trade and general press tend to focus on construction and permanent financing, but most of the projects reviewed in this report had spent upwards of half a million dollars in seed capital before even getting to the construction financing stage. Raising this amount of seed capital – much of which is spent on relatively fixed development costs – can be a significant hurdle for community wind projects, and in particular smaller community wind projects. Fox Islands Wind raised $350,000 by issuing contingent promissory notes (and beyond that amount operated on credit until the equity investment and construction loan came in (Baker 2010)). South Dakota Wind Partners utilized $80,000 in grants from its four founding members, along with an additional $300,000 investment from other board members, to flesh out the offering. The Coastal Energy Project funded some of its early-stage development work out of two Residential Energy Assistance Challenge (REACh) grants, and later received a $5 million grant from Washington state.

5.3 Piggybacking on Nearby Projects Can Help Ease the Burden

South Dakota Wind Partners provides the most obvious example of the benefits of piggybacking on adjacent projects. The PáTu project, however, has also benefited from shared infrastructure and local knowledge from nearby commercial wind development.

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5.4 Partnering With Experienced Professionals Can Create Opportunities

Although the projects profiled in this report are modest in size, they are nevertheless complex undertakings involving novel financing structures, which in many cases represent industry firsts. Each of these projects relied on partnerships with experienced professionals to provide access to a range of opportunities and to facilitate the project’s successful development. For example, EOS Ventures helped the Fox Islands Wind project procure turbines from GE and deliver them to the island site. Miracol Energy – a financial consultancy with ties to the tax equity market – helped the Ridgewind project get its foot in the door at Union Bank and advised PRC on the sale/leaseback financing. South Dakota Wind Partners is not only heavily dependent on Basin Electric, but also Val-Add Service Corporation, which assisted the project’s board of directors in conducting the intrastate offering and will help administer the project. Chinook Wind did most of the development work for the Coastal Energy Project, and several tax lawyers and accountants were critical to working out the financing details. Finally, after several false starts, the PáTu project brought in Vert Investment Group to piece together its final financing package.

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5.5 Consider the RUS As a Source of Debt

Although it has historically provided loans primarily to rural electric cooperatives, the USDA’s Rural Utility Service is able to provide non-recourse debt financing to standalone wind projects on a project finance basis; the Fox Islands Wind project stands as proof of this. Moreover, after having climbed the learning curve with Fox Islands Wind, and with expanded authority from Section 6108 of the 2008 Farm Bill, the RUS is interested in expanding its portfolio of wind project loans.27 The loan instrument used for this purpose to date – an “FFB Guaranteed” loan – is beneficial to wind not just because of the low interest rate (just 12.5 basis points above the corresponding Treasury yield), but also because the IRS does not consider government loan guarantees to be “subsidized energy financing.” As such, these RUS loans could be used in conjunction with the PTC (if/when access to the ITC/grant expires) without triggering a PTC haircut.

5.6 Don’t Overlook New Markets Tax Credits

Given their typically small size, community wind projects should generally strive for greater simplicity rather than increased complexity in financing structures. The realities of the market, however, often require that complex financing structures be employed in order to maximize available incentives. For this reason, NMTCs are worth keeping in mind should an appropriate opportunity present itself. Although NMTCs can be complex to structure, they do provide quite a bit of value (on a present value basis, effectively the equivalent of a second ITC), which in some cases could justify the high transaction costs of pulling together an NMTC deal.

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5.7 Be Prepared for a Long Haul

Developing a wind project can be a drawn-out process, requiring patience, tenacity, and adequate development capital. At least three of the five projects reviewed in this report have endured development cycles of five years or longer – despite being relatively modest in size. The PáTu project, in particular, demonstrates how it is easy to become a victim of circumstance with respect to global events outside of the project’s control. South Dakota Wind Partners, in contrast, was starting construction a little more than a year after first being conceived (not including the time that Basin Electric no doubt put into developing the larger project), once again demonstrating the benefits of piggybacking on nearby development.

5.8 The Shift from Construction to Commercial Operations Can Bring New Challenges

Although this report has focused primarily on project financing, the challenges do not necessarily end once a project has been financed and built. Several of the projects reviewed in this report have recently shifted from the construction phase to the operational phase, and are now facing operational challenges. For example, the PáTu project is now grappling with issues related to integrating its power into the Bonneville Power Administration’s grid. The Coastal Energy Project is also dealing with integration issues – voltage on the local grid is too high when all four turbines are operating (Grays Harbor PUD 2010). The Fox Islands Wind project has been working with island residents over the past year regarding noise complaints, experimenting with different operational strategies to try and minimize the impact on nearby residents. And, finally, Ridgewind Power Partners, LLC will essentially conduct a partial refinancing (of the special purpose project company, not the project’s hard assets) after the Ridgewind project achieves commercial operations, by implementing PRC’s Minnesota Windshare program.